Financial Authorities Conduct Stress Test on Private Equity Funds

Impact of Liquidity Controversies Including Lime Crisis
Full Implementation of Soundness Inspection Within Q2
Funds with Poor Results to Be Suspended from Subscription and Sales

[Asia Economy Reporter Park Ji-hwan] Financial authorities have decided to fully introduce a 'stress test' system in the second quarter to resolve liquidity issues in private equity funds that surfaced following the Lime incident, which involved a fund redemption suspension worth approximately 1.6 trillion KRW. Going forward, asset management companies will be proactively monitored for timely responses to investors' redemption requests.

On the 14th, the Financial Services Commission and the Financial Supervisory Service announced the 'Private Equity Fund System Improvement Plan' based on these details. The financial authorities pointed out that a direct cause of the recent Lime redemption suspension incident was the operation of open-ended funds despite a high proportion of investments in illiquid assets.

A Financial Services Commission official stated, "Due to a maturity mismatch structure that restricts redemption and repayment, it was difficult to respond to investors' redemption and repayment requests during fund setup and management, causing liquidity problems."

Accordingly, the financial authorities will introduce regulations related to the establishment of open-ended funds for funds with a high proportion of illiquid asset investments, applicable to both public and private equity funds. Specifically, setting up open-ended funds will be prohibited if the proportion of illiquid asset investments exceeds 50%.

The financial authorities also decided to mandate periodic liquidity stress tests for open-ended funds. Based on the test results, asset managers must establish liquidity risk contingency plans, including risk response measures and cooperation plans with custodians, investors, and administrative service providers. If liquidity concerns arise from the stress test results, measures such as suspending subscriptions and sales of the relevant fund through consultations with private equity fund managers must be prepared.

Additionally, measures to eradicate 'nominal private equity funds' that appeared in the Lime incident have been established. This is to block the sale of public funds disguised as private equity funds. If funds with identical or similar underlying assets and profit-loss structures are sold to more than 50 people within six months, they will, in principle, be regarded as public offerings.

Plans to resolve information asymmetry between investors, sellers, and asset managers are also included. To enable investors to invest in private equity funds under the principle of self-responsibility, the obligation to provide investor information will be strengthened. Sellers must inform qualified general investors of key information such as liquidity risks and whether the fund invests in layered structures when recommending investments. Asset managers must provide quarterly asset management reports to individual investors.

Measures to supplement leveraged investments, which exacerbated investor damage in the Lime incident, have also been prepared. The counterparties to total return swap (TRS) contracts for leverage purposes will be limited to securities firms' prime brokerage services (PBS). In particular, the leverage ratio under TRS contracts will be clearly limited to 400% of the fund's assets. Measures to prevent investor damage that may occur due to unilateral early termination of contracts by securities firms, the TRS counterparties, will also be established.

The Financial Services Commission plans to finalize and announce detailed system improvement measures next month after gathering opinions from stakeholders and experts based on this system improvement direction.

This content was produced with the assistance of AI translation services.